Flip-In Strategy
Strategy wherein the existing shareholders are given the right to buy additional shares, mainly at a discount, thus diluting the value of shares purchased by the acquiring company.
What is the Flip-in Strategy?
A poison pill is a defense strategy employed by a company's board of directors in the event of a hostile takeover. There are different poison pill strategies to thwart the company's effort, and the flip-in strategy is one of them.
In this strategy, existing shareholders are given the right to buy additional shares, mainly at a discount, thus diluting the value of shares purchased by the acquiring company.
In addition, the issue of shares increases the total outstanding shares, thereby reducing the percentage of the stake already acquired by the company.
The flip-in is a clause stated in the charter or bylaws of the target company. The clause offers current shareholders of a targeted firm, excluding the hostile acquirer, the option to buy more shares at a reduced price.
These buying options become available before a prospective takeover once the potential buyer has acquired a specified percentage of the outstanding shares (often 20 to 50 percent).
Therefore, the risk of unfair dilution in the target firm exists if the potential acquirer accumulates more shares than authorized and sets off a poison pill.
Thus, the threshold level effectively establishes a cap on the total quantity of shares that any shareholder may acquire before being forced, practically speaking, to start a proxy fight.
Flip-in Strategy Example
In 2003, Oracle publicly disclosed its offer to buy PeopleSoft for $16 per share, or around $5.1 billion in cash. However, PeopleSoft turned down Oracle's offer and sued the company in a state court in California, claiming that Oracle had hurt its reputation and demanded $1 billion in compensation.
Also, PeopleSoft implemented its poison pill protection. In the case of a hostile takeover effort where the acquirer has acquired 20% of the company's stock, the defense permitted the company's current owners to buy the stock at half price.
To defend itself, PeopleSoft not only approved a poison pill that allowed the board to flood the market with additional shares but also established a "customer assurance program."
That plan pledged to reimburse consumers five times the cost of their software licenses if PeopleSoft was sold during the next two years, establishing an estimated liability for an acquiring business of up to USD 800 million.
Oracle then increased the offer to $26.50 per share (or $10.30 billion). The $26.50 per share offer, which was 66% higher than the initial $16 offer, was accepted by PeopleSoft. Because the final price was satisfactory to PeopleSoft, it consented to the hostile takeover.
Even though PeopleSoft ultimately sold to Oracle, its shareholders benefited from the defense strategy.
Flip-in Strategy Advantages and Disadvantages
The advantages and disadvantages are:
Advantages are:
- It makes it easier for the current management and board of directors to control the company's business activities.
- It is an effective deterrent against hostile takeovers.
- It enables corporate boards to dilute a shareholder's ownership, attempting to take over the company.
- It might be used as a negotiating tool to get a better deal.
Disadvantages are:
- The corporation risks declining share prices by issuing additional shares at a discount.
- Because poison pills are available, the board is no longer obligated to act in the interests of its stockholders.
- This tactic may occasionally motivate ineffective managers to keep working, hampering the company's growth.
Flip-in vs. flip-over poison pill
The two main types of poison pills are flip-in and flip-over. The widely-used tactic known as "flip-in" enables current owners (other than the prospective acquirer) to purchase additional shares of the target firm at a significant discount once their holdings in the company have reached a predetermined threshold.
A flip-over approach, on the other hand, permits shareholders to purchase substantially discounted stock following a successful hostile takeover.
Flip-over defense strategy is the opposite of the flip-in strategy. In contrast to flip-in poison pills, which let current shareholders buy shares of the target firm at a discount, flip-over poison pills let existing shareholders buy shares of the acquiring company at a discount.
A flip-over poison pill approach is only employed when a hostile takeover is successful, and its clause needs to be included in the acquiring company's bylaws.
While the flip-over pill is activated after the agreement is completed and a merger is confirmed, ownership flip-in plans are activated before a potential takeover.
Other types of poison pills
Apart from flip-in and flip-over poison pills, companies use various poison pill strategies to thwart hostile takeover attempts. The type of pill available determines the pill a corporation uses.
"It is challenging to add a poison pill if it is not in your charter," says Derek Horstmeyer, a finance professor at George Mason University's School of Business.
In addition to flip-in and flip-over poison pills, businesses also employ the following defensive tactics:
Preferred stock plans
Often referred to as "original plans," preferred stock plans are one of the first versions of poison pills. This strategy's core idea is touting the number of shares accessible to a potential buyer. Then, the company distributes the converted preferred stocks to the present owners as dividends.
First, the preferred shareholder has the right to redeem their shares at any moment for the highest price they paid for the common stock.
Second, the preferred shares may be converted into voting equities if the merger occurs.
Back-end rights plans
Back-end rights plans include redeemable right dividends for shareholders. If the bidder meets a particular threshold, the dividend is activated. The rights enable the holders of the shares to swap them for a back-end price higher than the going market rate.
As a result, the acquirers will likely be dissuaded from completing the transaction once the back-end strategy is in place. In addition, the stockholders are incentivized to wait out for the higher back-end price. Thus, it is likely that a bid below that amount will not be accepted.
Voting plans
Voting plans issue preferred stocks that provide current owners of a company with enhanced voting power.
In this case, the preferred stock outweighs the voting rights, so even if a hostile acquirer purchases a specific threshold of common stocks, he would still be unable to determine the terms of his offer. Voting plans create a situation that is less attractive to potential buyers.
Conclusion
It is difficult to determine whether or not a flip-in poison pill is effective. A company's experience with Flip-in Poison Pill might be positive or negative.
Although it is a very successful defensive strategy, it could discourage other prospective investors. On the other hand, the plan is quite helpful to the current stockholders. It lets the shareholder purchase the shares at a significant discount, generating a theoretical profit immediately.
However, it would only continue to be advantageous for the shareholders provided the target company's stock price remained higher than the cost of acquiring more shares.
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